Brookfield Corporation (BN) Q1 2014 Earnings Report, Transcript and Summary

Thank you for standing by. This is the Chorus Call conference operator. Welcome to the Brookfield Asset Management 2014 First Quarter Results Conference Call and Webcast. [Operator Instructions] And the conference is being recorded. [Operator Instructions] At this time, I'd like to turn the conference over to Amar Dhotar, Investor Relations for Brookfield Asset Management. Please go ahead, Mr. Dhotar.

Thank you, and good afternoon, ladies and gentlemen. Thank you for joining us for our first quarter webcast and conference call. On the call with me today are Bruce Flatt, our Chief Executive Officer; and Brian Lawson, our Chief Financial Officer. Brian will start this afternoon discussing the highlights of our financial and operating results. Bruce will then discuss our views on the current investment and market environment, as well as a number of our major growth initiatives in the quarter. At the end of our formal comments, we will turn the call over to the operator to open the call up for questions. [Operator Instructions] I would, at this time, remind you that in responding to questions and in talking about our new initiative and our financial and operating performance, we may make forward-looking statements. These statements are subject to known and unknown risks, and future results may differ materially. For further information for investors, I would encourage you to review our annual information form or our annual report, both of which are available on our website. Thank you, and I'd like to turn the call over to Brian.

Great. Thank you, Amar, and good afternoon. We held our annual meeting today in Toronto where we discussed the company's results. And many of you participated in the meeting, heard what we had to say. So I will be a bit brief in my remarks this afternoon. And as always, as Amar mentioned, we welcome your questions. The year is off to a strong start. Funds from operations for the first quarter of 2014 was $492 million. And setting aside disposition gains, the FFO from operating activities increased by 6%. Now this reflects substantial increases in fee revenues and in power prices, although it was partially offset by a decline from some of our more cyclical investments. So it -- that somewhat overshadowed a lot of the really strong growth that we had throughout the core parts of our operations. Disposition gains were $105 million in the quarter versus $325 million a year ago. I think it's worth remembering that the 2013 quarter included a $172 million gain on the partial -- sale of a partial interest in Brookfield Renewable Energy Partners. We are experiencing strong growth in almost all our major businesses due to investments we've made in new assets and organic expansion initiatives. We increased our fee-bearing capital to $84 billion, up from $80 billion at year-end, and $74 billion at the end of the 2013 quarter. The increase in fee-bearing capital was driven primarily by our, in the most recent quarter, by our successful tender offer for our office property portfolio. We expect to acquire the remainder of the portfolio in June. And we believe that this transaction establishes Brookfield Property Partners, our flagship-listed entity in this sector, as a premier global commercial property company. We are currently marketing 4 private funds with a target of more than $2 billion in third-party capital. And this should provide additional growth in our asset management activities. FFO from the asset -- from our asset management business rose by 44% to $88 million, and was nearly $900 million on a trailing 12-month basis. And this reflects the substantial growth in fee-bearing capital since this time last year, as well as sizable carried interest recognized in the fourth quarter of 2013. Our renewable energy business benefited from significantly higher electricity prices. A colder-than-normal winter this year meant that prices more than doubled in New York and New England compared to last year, and these are major markets for our electricity. We also benefited from improved pricing in Brazil and acquisitions of hydroelectric generation facilities in the United States over the past year. As a result, FFO from our renewable energy portfolio was $164 million compared to $76 million in the first quarter of 2013. In the letter to shareholders, we discussed our view on future power prices. The short version is that we expect the price of electricity is going to increase in order to meet the continued demand for renewables and sustainable energy gas, natural gas pricing. So -- and we feel we're very well positioned to benefit. Our FFO from our property group declined from $123 million that we recognized in the prior quarter. This reflects the fact that we have a reduced interest in Brookfield Property Partners following our spinoff to shareholders in April of last year and subsequent equity issues. We are also working through the expiry of the large lease in New York, which we've discussed in the past, but we are seeing a significant pickup in leasing activity in this market, as well as other major centers such as London. New leases in the office portfolio are being done at 6% above the expiring rents. And it's even more -- it's even stronger in our shopping mall portfolio, where we're seeing new leases being done at 11% higher than the expiring leases. And we're executing some highly profitable redevelopment opportunities, all of which lead to very strong growth potential in both these businesses. We continue to actively manage capital in our property business. We sold 22 office, retail and industrial properties for proceeds of $1.2 billion in the quarter. And over the next 18 months, we anticipate disposing of approximately $2 billion in office properties, again as part of this -- the active management of these portfolios. In our infrastructure business, FFO was virtually unchanged at the Brookfield Asset Management level at $59 million. The results were steady even after we sold the large Timberland portfolio last year. We had excellent growth in FFO from our transportation business, with particularly strong performance from our Australian railroad and the expansion of our Brazilian toll road business. During the quarter, we announced plans to acquire a port in Newark and the district -- and district energy systems in Chicago, Las Vegas and Seattle as we continue to expand our operations in these businesses. Our private equity assets generated FFO of $59 million. Now this is lower than last year, as I mentioned. In part, this reflects the sale of the assets, but also, we experienced lower prices and volumes in our panel board business following exceptional results in the first 3 months of 2013. Just returning to the private funds. Uncalled commitments to the funds now stand at $8 billion, which together with the $6 billion of core liquidity between us and our major affiliates, gives us $14 billion of liquidity to pursue the many attractive investment opportunities that we are seeing. And finally, the Board of Directors declared a quarterly dividend of $0.16 to be paid at the end of June, which represents a 7% increase on an annualized basis. So thank you, and now I will hand it over to Bruce.

Thanks, Brian, and good afternoon. As Brian explained, the year is off to a good start. From an investment perspective, the most notable accomplishment in the quarter was Brookfield Property Partner's tender offer for the office portfolio. BPY owns 90% now, and that will go to 100% next month when they have the final completion of the transaction. This is an important step in the evolution of BPY, but only the start. And we're now positioned as one of the leading global companies in commercial properties, with a very high quality portfolio. And as part of the transaction, we increased the public float and anticipate it'll lead to a stronger public market following. But obviously, there's a digestion of some of that stock in the market going on at the current time. Following this transaction, the IFRS appraised value is around $25 a unit. However, the -- we estimate the liquidation value is higher than this. And largely, that's because we do IFRS valuations on 10 and 20 [indiscernible] cash flows, not current prices. And the prices being paid for high-quality properties these days are extremely robust. More important than that probably is that the current value of BPY is our belief that we can create significant additional value in the business with our global franchise. And we believe that we should be able to compound at 15% plus similar to what we've done in the past. And if we can achieve that, BPY should do extremely well for all of the investors, including ourselves. Furthermore, we believe that there'll be other opportunities over time to make acquisitions and utilize this entity to create further value. And we're never sure or we can never really tell you when that will occur. But as it has in the past, we're quite sure there will be times when we will be able to accomplish that. When we look at growth opportunities overall in our platforms, we continue to see value opportunities in Europe and in many of the emerging markets, particularly in Brazil, where we have a major presence, but also in China and India. We've discussed these themes of investing in past, and our thesis remains intact. First, after many years of these markets being awash in capital, we find that there is less capital available in the market. Banks and other lenders are exiting many of these markets. And as value investors, we like to put money to work when capital is more scarce. And that is the situation today. Second, with regard to emerging markets, we do see opportunities to acquire assets on scale. Sometimes, it's not generally available in the developed economies. And for example, we just acquired 3,000 miles of toll roads in Brazil. And to give you a perspective, an asset of this size simply doesn't exist in North America to be purchased. So the opportunities, frankly, are much larger in some of these emerging markets. Finally, we're already investors in these countries, in particular in South American countries. And we have a lot of experience in these markets. What that means is that we can acquire assets with a high degree of confidence and in addition, put further money to work organically to expand our existing portfolio, which often offers higher returns and lower risk for the investments we make. I would like to make one further observation about our quarterly results. We had an excellent performance from our renewable energy platform. It was the first time in a number of years. That was largely the result of an increase in prices for the electricity we generate because water levels were about consistent with expectations. Part of that increase was due to cold weather in the quarter. But in addition, we believe that the trend to higher prices will continue for a couple of reasons. And we take this view because the most of the North American electricity system is in excess of 50 years old and heavily reliant on coal and gas. And bottom line, it continues to need to be replaced and will be. And in the current price environment, very little investment over the last 7 years has been made to replace the aging infrastructure and make the power systems more environmentally sustainable. Our belief is that both physical demands and these policy initiatives will require further investment in new cleaner supply, primarily in the form of natural gas and electricity and renewable electricity. Continued investment in these technologies requires that electricity prices rise, and we believe they will settle in excess of $100 a megawatt hour in 2014 dollars to justify long-term investment. And as power prices increase, our renewable portfolio is positioned to generate significantly higher cash flows as a result of this number of factors. With those remarks, Brian and I would be pleased to turn it back to the operator, and we take any questions if there are any.

[Operator Instructions] First question comes from Cherilyn Radbourne of TD Securities.

Wanted to start by asking you if you could just give us a bit more perspective on Europe, it does seem like a lot of capital has been raised to target the stress in that region. So I just wonder if you can talk about the level of competition for deals, and whether you still have a pipeline of opportunities where you believe you've got a competitive advantage either for scale reasons or as a result of your operating expertise.

Thank you for the question. It's Bruce. And I guess, I would say if we were -- when we're sitting here 18 months ago, I would have imagined that capital would be less available in Europe and probably more available in Brazil, China and India than it is today. I'd say there's no doubt the pendulum has swung where Europe has definitely -- is receiving more than its share of money today from opportunity fund. And people have, I guess, stopped the deathwatch on whether the countries are going to go out of business. And therefore, a lot of money is flowing in. So I'd say firstly, there's a lot -- there are less opportunities, although I'd say there's -- because there's more money, but there's a lot less risk to the opportunities that are there, because you just weren't sure of what was actionable before. As to whether we can still put money to work, I believe that there's still a very substantial amount of opportunities available to us and others because even though there's more money available, there's just a lot of things that need to be reorganized and recapitalized with fresh money. And therefore, I think there's lots of opportunities for us in the future.

Great. And then I just wondered about the portfolio that you sold out of your public securities operations. Could you just speak a little bit more about that transaction and what you're trying to do strategically?

Sure, Cherilyn, it's Brian. So that's part of the ongoing refocusing of the business on areas that are, I'll say, more consistent with a lot of things we do elsewhere in the organization, and also to focus it more on higher-margin businesses. So this was a bit more of a traditional fixed income business that was heavily geared towards insurance portfolios. And what we've been focusing more and had tremendous success was on building an infrastructure equities business. There's -- we've -- I think, anyway, billions of dollars falling into that part of the business, as well as the traditional real estate equity side of it. So that's really what it's been about.

The next question comes from Brendan Maiorana of Wells Fargo.

Bruce, in your letter, you talked and you talked about it on the call that power business and how you had a nice recovery there. And now I think you mentioned kind of longer term, $90 to $100 plus per megawatt hour electricity prices. What does that translate to in terms of where natural gas prices would be to translate into those power price levels?

So when -- firstly, there -- our power's different than most people's power because we have a number of ancillary products that we receive proceeds for. We receive proceeds or we should or do receive proceeds for green attributes of most of our power. We receive proceeds for ancillary revenue like being able to be available during the day when others can't be because of the type of plants we own. And third, we receive other forms of proceeds for having peaking ability of many of our plants. So the first point is our power is different than a coal plant, for example, that just has to run all the time. So that's the first component of it. The second part is that we, and maybe try to answer your question is, our view is that gas prices long-term will be in the $5.50, $6.50 range over the longer term. And that will convert into the prices that you see that we expect on the longer-term numbers. And so that's generally where our view is on pricing of gas.

Okay. So just to clarify, so the $90 to kind of $125 per megawatt hour, that's inclusive of sort of the $30 of ancillary revenues that you typically get. That's correct?

No, no. So just to be clear, we -- if you take a renewable plant and you price out the electricity component and you use an equivalent of $7 -- $6 to $7 in gas, you'll come up with a $90 to a $125 price.

Okay. So if you were able to get that, then you could also get the ancillary revenues on top of the contracted price that you could get over the long term?

That's correct. And in fact, there wasn't a whole heck a lot of that in the previous quarter, but we expect a lot more of that to be coming down the road, which should lead to even stronger pricing dynamics.

And I guess our view longer term is that there's some percentage off of that price that we'll lock in power at, which we've continued to do in Brazil this quarter and in North America over time, but not in the recent couple of years just because you weren't even trading close to the long-term replacement cost of energy.

Yes, that makes sense. So just last point of clarification, Brian. I think in the supplemental, your uncontracted power you sold for $105 a megawatt hour. So just to your last point, in gas environment, that was, call it, I don't know, $5 to $6 this past quarter, that didn't include much of the ancillary revenues. Is that correct?

There were some ancillary revenues. What we -- it was what we haven't -- which we will be getting over the next year or 2, is on the capacity side and on the green energy credits. But what you did see is some supply constraint going into that market that led to stronger pricing.

Next question comes from Michael Goldberg of Desjardins Securities.

You've been monetizing investments related to recovery of the U.S. housing. Are you likely to continue that monetization? And in that light, would it be reasonable to think of your investment in Brookfield Residential even as nonstrategic?

Michael, it's Bruce. So I guess the first thing I'd say is the U.S. housing recovery, we believe, is still intact. And we believe it continues to be a very positive factor on U.S. GDP, and will be in the future for a number of years. That said, it seems to have had a stall in that recovery. And therefore, everything related to housing in the last 6 to 9 months has been -- is much higher than it was 2, 3 years ago obviously. But it sort of stalled at the prices where we are. So what you've seen is that we haven't done much for the last 3 to 5 months because we're not happy. We wouldn't do transactions at the prices where things are today, and we expect them to be higher in the future. That said, when we do achieve those numbers, we'll continue to harvest capital out of a number of those businesses. And our intention was never to have a substantial amount of capital as we do in Brookfield Residential. We've put an enormous amount of money in at the bottom of the market. It's gone up a lot in value. And at some point in time, we may take some money out of Brookfield Residential, but we have no intentions of that today.

Okay. If I could have another one. If BAM could be involved in resolution of E.F.A., particularly encore, could this potentially be another GDP, in other words, benefit of fixing the balance sheet of a business with great assets?

So that's a transaction in the market that we probably wouldn't make a speculation on, Michael. But -- so I don't really have any comment on that.

Next question is from Mario Saric of Scotiabank.

Just one question for me and it relates to kind of this notion of rising allocations to real assets. It seems confirmly entrenched, and there's more room to go. So the question's not so much on if institutions or your LPs are increasing allocations to real assets, but more on how they're doing it, and whether you're seeing any trends with respect to investing through private funds, investing directly in real assets or perhaps increasingly looking at publicly traded real asset securities to gain that incremental exposure?

Mario, it's Bruce, and I'd say yes to all of the above. And we are seeing global institutions, and that goes all the way from the smallest institutions up to the largest, increase their allocations to public securities, which own real assets. We're seeing them increase their allocations to listed assets. We're seeing the increased allocations to private funds. And we're seeing the larger ones, who actually can do it on their own, increase their allocations to direct investments. And I guess our view after continuing -- speaking to them all the time is that, that will continue. And each one of them had a different strategy and fits into different buckets. And some of them are large, some of them are small. So whether it's listed, private or public securities, it depends. But our view is that the allocations are continuing to go up and will continue to go up.

Okay. And I guess based on your discussions with those partners or clients, do most of them have the ability to invest in public securities today and just haven't been active? Or are you seeing more of them enter that field?

So when you say public securities, meaning they're allocating money to us to buy listed real estate or infrastructure securities?

No. So let's say they're giving Brookfield $100. And historically, they've given Brookfield $100 to invest in a private fund, but instead they are looking at arguably giving Brookfield $100 by buying either BIP, BEP or BPY with that $100 because each of those underlying vehicles will co-invest in the private funds that they're looking at. I'm just wondering whether you're seeing more of that take place in the last, let's say, 6 to 9 months as opposed to 2 to 3 years ago?

The answer is yes. A number of our clients have invested in our listed entities, and you will -- may have seen that. They continue to give us money for listed securities that we're buying in the market, which are other people's securities, and they're also giving it to private fund. So it just depends on each fund and what their allocations are.

The next question comes from Bert Powell of BMO Capital Markets.

Yes. In the supplemental, the dry powder on the funds went from $9.8 billion down to $7.9 billion, which given that the total AUM stayed flat would indicate that the cadence of investment in the quarter was $1.9 billion. Is that -- am I thinking about that the right way? And -- or sorry, first of all, was that the right number? And two, is that the kind of cadence that you're thinking about in terms of burning through of, I guess you can use the term, fund backlog?

So I'll just start off quickly with that, Bert, and Bruce may fill in from the investment side of it. That is always going to ebb and flow just based on the timing of when the acquisitions arise, but you're right. A lot of that was money that was put to work. We have been successful in investing a lot of the capital in the large infrastructure and opportunity property fund that we raised last year, as well as on the private equity and some of the other funds. So it's certainly not out of line. And of course, what that does free us up to do is to start thinking about follow-on as well. So does that makes sense?

Yes. That's kind of what I was getting at, Brian. I was just trying to figure out whether this starts to -- you're in the market with funds to start to accelerate going out or raising additional funds.

Yes.

Okay. And then the -- just one other question. On the renewable power just kind of circling back on that in the quarter, this was a pretty -- weather had a big impact on pricing this quarter, and so the realized price per megawatt hour was pretty healthy. Can you just give us a sense of where that is for you as we roll off the first quarter? How do things look in April and May on that front? Are we -- are they back into that $75 a megawatt hour pricing?

Yes, it's certainly backed off, Bert, if you look at the screens. Although one thing of interest, and this is one of the things that we think is quite important as you look forward is, what does it look like, say, in the first quarter of next year. And that's one of the things that we've seen tighten up a lot in terms of pricing, both in terms of what you would see in an electricity price, but also to Bruce's earlier point, the ability to sell forward capacity, which is very lucrative for us as well. So while there's no doubt there was a large -- some weather-driven spike that's being driven -- peak in pricing during the first quarter, it has backed off from that. But we're seeing a lot of favorable things going forward as well.

The next question is from Andrew Kuske of Credit Suisse.

I guess the question's for Bruce, and it's really around the Colonial transaction where in your -- a lot of your talk about the gain that you're going to book on this, which is very impressive in a relatively short period of time. But I guess if you could just give us a bit more color on that transaction in itself and a bit of a genesis of it, and I think we all know really what happened in the end. But how would you see this kind of transaction being done on a go-forward basis if you had a standalone credit fund for clients, the opportunity fund and then also some of the dedicated real estate funds that are essentially embedded within BPY?

Yes. Andrew, what you're thinking about is conflicts between them?

Exactly. I think the genesis of Colonial. Clearly, there is distressed paper in the marketplace. And to me, it would seem tricky would the credit fund do it or a future credit fund versus an opportunity fund and just the intermingling of all of those things.

Yes -- no. Thanks for the question. I guess I'd just say that, Andrew, I think you know we've been very methodical about setting up the business over the past 10 years to ensure that our listed entities and our private funds are, and BAM for that matter, are 100% aligned. So that there's never any conflicts as to who's doing what. Our credit hedge fund that we're in the process of setting up is going to be a noncontrolled position in securities and credit, which will not really conflict with the other businesses. And in fact, we believe it'll be additive to the other business because if something could possibly be a controlled investment, that will be for one of the businesses. And if not, the opportunities will go into the credit fund. And Colonial was a situation where we could buy $1 billion of bank debt of a $2 billion situation, and therefore, have a significant chance of being able to convert it into a control position in the equity. And that would clearly be a situation in which would go into our private real estate fund and the listed entity, BPY, obviously. If we could only buy $30 million of that, there would be no sense for BPY to be involved. But I guess our view is that it's additive to the franchise to be able to have that opportunities because it gets us into situations.

That's helpful color. And then I just, I guess as a follow-up to that, are you seeing signs of increased deal flow in particular out of Europe with some of the ongoing balance sheet de-leveraging efforts from some of the banks?

Yes. There's no doubt there's a lot of activity going on in Europe related to what's going on with the balance sheets of the financial institutions, and I think that'll continue for probably 3 to 5 years. And so while there may be a short period of time where there seems to be a lot of money around in Europe chasing a few opportunities, there aren't that many people with that much money in the longer term. And I think there will be opportunities for everyone, and we just have to pick our spots.

[Operator Instructions] Your next question's from Alex Avery of CIBC.

Just thinking about BAM as you continue to evolve this flagship publicly traded vehicle structure, and I guess a core attribute to your strategy and your, I guess, your pitch as an investment manager is that you have the flexibility to allocate across different asset classes and different geographies depending on opportunities as they arise. And there's, I guess, something of, I guess, a challenge there in that the bulk of BAM's capital, 75%-ish, is invested in the publicly traded shares of the flagship subsidiaries, which I think inherently limits BAM's ability to reallocate that capital. Just wondering if perhaps you could provide a comment on that? Your earlier comments suggested that you're definitely very bullish on, for instance, the renewable power sector over the medium and long term, and whether, I guess, as a potential solution you need to consider rolling some of BAM's investments into the limited life funds that are housed within those flagship vehicles as a natural solution to providing reallocation opportunities?

Yes. I'd say firstly, at BAM's level, we can always sell things on our own balance sheet, including some of the interests in those entities, which we don't otherwise need to hold as a long-term core position. So if we needed money to go into one of the sectors, we could always sell shares. That's not a statement that we're going to or intend to, but we could always do that. That's the first comment. The second one is our view has been that within these businesses, we should be diversified. In each one of these businesses, infrastructure, renewable power and property are extremely large today. And in fact, each one of them in their own right is bigger than all of BAM was 10 years ago. So just to put that into context, they have enormous -- each one of them has enormous resources and access to capital within their own franchise. And in fact, they're big and diverse in each one of them such that if they choose to put money into Brazil, they could monetize money out of North America. And one of the ways to do it is obviously sell assets to institutional clients. And that's always on the list, and it's something possible. So they can either free up money themselves within the franchise and selling assets or do other things within the company. So there are, by virtue of the structure we have, we do have multiple levels of access to capital, and we just have to choose the one that's best for all the investors.

But in terms of actually executing on sales of owned interests in your flagship vehicles, it's not just a matter of capital reallocation, but also, I guess, your sponsorship of the vehicle and perhaps any market signal that you might be sending if you were to liquidate. Is that...

Yes. The only thing I'd say is we've been very clear to people that we intend to own 30% or around 30% of these entities in the long term. And we think that's a core position that we're going to hold. Over and above that 30%, we're just -- it's just capital allocation. And it means that at a point in time, there may be opportunities for us to monetize it. And if we can put the money somewhere else, we may do it. But that's not saying that we think any less of the vehicle. It's just we need the money for something else.

So that 30% level is sort of the anchoring?

Correct.

There is a follow-up question from Michael Goldberg of Desjardins Securities.

In your plan to sell $2 billion of assets in BPY, how much would that reduce FFO contribution?

Well, if you just assumed that you're selling at, I don't know, let's just say you're selling it at a 5% cap, then it'll just be 5% of that, and then you'd have to take off. Then of course, you need to be also deleveraging at the same time in terms of the associated debt.

Yes. $2 billion at 5% is $100 million. So you'd reduce FFO by $100 million, but you'd pay off your debt in the way. So...

Let's call it half of that.

Yes.

But then will you be redeploying, you be reinvesting that? Or what are you doing with that as well to the extent that there's net equity after you pay down the debt?

Okay. So yes, but that's what I thought you were saying, that the use of those funds was to pay down the debt.

Sorry, Michael, if we were -- if we have -- if we sell $2 billion of assets and we sold it on a 5% return, that's $100 million, our boring costs today are probably 5%.

Yes, on a term basis.

On a term basis. And therefore, it's flat, flat to the bottom line FFO. We sell $2 billion at 5%, and we pay off $2 billion of debt that's costing us 5%. So it's flat to the bottom line. Of course, you might sell something that's a little bit higher or a little bit lower and then it's a little bit off of that. But in general, that's what it is.

Yes, and some of the debt may be floating.

This concludes the time allocated for questions on today's call. I will now hand the call back over to Mr. Dhotar.

Thank you, and that concludes our call. We thank you for joining us and your time. We look forward to updating you next quarter. Thank you.

Ladies and gentlemen, this concludes today's conference call. You may disconnect your lines. Thank you for participating. Have a pleasant day.